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Wednesday, March 2, 2016

Earnings Review: EOG, Marathon, and Continental

With the fourth quarter and annual earnings reports coming out, analysts are able to get a better look at the oil and gas production scene in the United States. Crude oil sits at just over $34.00 today after a small bullish boost lifts it from the high $20's of last week. Just about a year and a half ago, oil executives and energy analysts might have called someone crazy if they had predicted those prices in 2016. Bewilderment aside, oil and gas firms have actually proven to be quite resilient under these sudden bearish conditions.

At the peak in 2014, prices as high as $107 prompted large revenue streams to flow into the coffers of oil and gas companies just beginning to reap the benefits of the new develops in shale technology. New discoveries in North Dakota, Eagle Ford, and the Bakken fields became more viable as fracking allowed deeper and more unorthodox ways of drilling. During these days, equities like Exxon-Mobil and Halliburton's common stock were among the most traded in their industry, and they certainly proved their worth. Fast-forward almost two years to record lows that bottomed out around $26 with losses up to 75.8% over that time period. Just now, analysts are claiming a relative stabilization has been reached with U.S. producers projected to cut and OPEC reduced to capping output. It's no secret that earnings reports have been low points for the energy sector which dropped -34.3% of its sales in the United States. FactSet projections have another -16.1% of sales in the current year. In the same time period, production of oil and gas per day increased 6.4%.

In order to get a closer look at what some companies are expecting out of 2016, the investors reports of three important shale producers will be reviewed: EOG Resources, Marathon Oil Corporation, and Continental Resources. An article from Wall Street Journal recently referenced these three entities as some of the leaders in the industry that have elected to reduce production in the coming months. Here is what they have to say.

EOG Resources (EOG) EOG reported a fourth-quarter loss of $149.5 million or -$0.27 per share. For the full year, a net loss of $33.9 million dollars or -$0.06 per share. These numbers were the first negatives to come out of EOG this year with the last three quarterly EPS just above $0.00. The losses were attributed to a steep drop in commodity prices compared to operating expenses, which was 42% for the total 2015 year. Despite a large drop in exploration and development expenses, total company production dropped just 4%. Such a disparity can be explained by the choice to stall pumping of plays that have yet to be fully developed instead of wells that are ready to pump in the near-term. The idea of cutting costs on long-term projects caused the relentless increase in rig utilization that prolonged the glut in the United States. The failure to add wells that would have been added in a bullish environment forced the rig utilization percentage to rise as the normal amount of closing wells was unchanged.

EOG continues to support this strategy after a projection of a 5% decrease in 2016 production is coupled with a 56% drop in exploration and development expenditures. Because of the desire to keep pumping in the short-term, EOG expects to complete 200 less net wells in 2016 compared to the previous year. This will represent a total of 45-50% decrease in year-over-year capital expenditures. This short-term approach to profiting off the oil glut will be effective if prices recover rapidly and robustly. Otherwise, EOG will be forced to reinstate large parts of their exploration and production operations at a loss or risk stagnate growth. The main difference between firms with expectations of a short glut and forms with expectations of a longer one is the decision of which assets to balance against debt. Some are choosing to stock up on cash while others, like EOG, are relying on long-term, undeveloped assets that they predict will appreciate. The 2016 capital plan also includes a move to take advantage of over 3,200 "premium drilling locations capable of delivering solid rates of return at low commodity prices." This statement produces many questions and doubts. How big are these locations? How developed are they? And finally, what is considered a "low commodity price?" However, if EOG is efficient as it has been in utilizing shale techniques in the past, even a slight recovery in oil prices can stabilize the sales of this company. Although, the downside risks in the case of a long-term glut through 2017 and 2018 are real.

Out of Houston, Texas, Marathon Oil reported a fourth-quarter loss of $323 million or -$0.48 per share. On the year, a loss of $869 million was realized or -$1.28 per share without items that are not typically represented in analyst's estimates. The actual reported net loss was $2.2 billion or -$3.26 per share. These losses accrued despite a 2015 capital program that was $500 million below the budget. From last year, total exploration, production, and G&A expenses decreased by 24% while total company production growth was 8%. Again, here, Marathon has elected to sideline long-term programs in order to preserve the operation of developed wells. Here, though, the 2015 production programs have sought to increase production probably to offset the atypical losses of over $1 billion. For 2015, Marathon logged an impressive 157% replacement ratio as it keeps long-assets in the ground. Just as the long-term assets have been stockpiled, cash and other liquid assets have been increased to $4.2 billion. It appears as though Marathon is bolstering near-term competitiveness in hopes that prices will inflate and all that cash can be poured into idle assets. A 20% reduction in the workforce and $315 million in divestitures support this observation as well.

Total production of continuing operations for Marathon increased by about 6% even though quarterly production fell by 1.5%. An interesting year-to-year trend is a reduction in foreign production in every kind of oil and gas. In fact, international output decreased by 8.7% while U.S. output jumped 13.0% at the same time. American companies that have international plays might experience a similar trend in order to reduce transportation and administration costs that might make foreign oil more expensive to pump especially with the growth of the local shale production in North American plays. These wells will typically prove to be cheaper to produce and easier to store. The only international area that increased output was in the United Kingdom where oil was realized at a higher price than North American fields. Marathon wells in Equatorial Guinea and Libya, on the other hand, were discontinued as their realized prices were the lowest. On top of that, unit production costs were well under the guidance levels for the year allowing for more growth without increasing production substantially. Based on the large amounts of cash that Marathon has accrued and its ability to cut costs under its guidance, the company should be able to absorb losses in the future. Although they are positioned well to survive a short-term glut or a long-term glut, Marathon does not appear to be betting on either outcome. Do not look for this firm to experience any major growth spurts as they have played the glut rather defensively

Continental reported a loss of $115.5 million or -$0.31 per share for the year of 2015. In the fourth quarter, the company finished with a loss of $86.6 million or -$0.23 per share. The headline for the press release centered around growth in one of the newer plays acquired by the firm called STACK. The three new, over-pressured wells in Oklahoma were developed further in order to optimize the recovery and rate of return in the region. Similar to Marathon, Continental finished the year $200 million under its $2.7 billion operating expenditures budget. In a third-quarter presentation, it was approximated that $1.5 to $1.6 billion would be needed to sustain a daily production of 200,000 boe for the year and possibly 2016. If that's true, the 224,000 boe annual output for 2015 puts operating expenditures at about $2 billion total. If only $2.5 billion was spent, we can assume that estimates of exploration and development costs were a smaller fraction of the budget. It is likely, again, that Continental has subscribed to ideas and plans similar to Marathon and EOG.

Unlike Marathon and EOG, Continental reported large-scale development on their SCOOP region which will supposedly earn rates of return as high as 40% for WTI prices around $40. Out of the three analyzed today, this program appears the most capital intensive (and perhaps promising) while producing almost a third of the total output. Investing in SCOOP would be a great way to access premium wells at a time when high rates of recovery and low costs are a must. On a year-to-year basis, Continental has dropped production in smaller areas to make way for increases in the North Dakota Bakken and SCOOP plays. These two large plays increased by 37.7% over the past year while outputs in smaller regions dropped 8.7% of production. This could be a way of trimming the most expensive production in order to pump the cheap oil first, but this cannot be supported because unit costs for each area are not provided. While information regarding costs is less detailed, Continental delves into its debt situation with a plan to maintain the health of the balance sheet. It reports a borrowing capacity of $1.9 billion which is more than enough capital to support 200,000 boe of daily production which was valued at just under $1.6 billion earlier in the release. The firm further stresses its desire to remain liquid by setting a net-debt-to-capitalization ratio limit of 0.65. By the end of the year, that ratio was just 0.58. Continental's capital position, as well as its dedication to honoring it, is a defensive move with a recognition of the possibility of a long-term glut. At the same time, the development of the SCOOP play shows the company's desire to keep growing despite the need to trim costs. As long as the wells are able to pump inexpensively in that location, Continental could be in place to secure more profits with a healthy current asset position and the ability to pump even larger amounts by bringing the smaller, now idle play online.

When analyzing financial positions, one should always take into account the different scenarios that can affect the future cash flows of a company. All of the uncertainty in the market coupled with volatile conditions makes for a large cone of projection of the price of oil. Just take a look at EIA estimates, and it appears evident that the trend is not evident. Fundamental analysis of individual companies in the oil and gas industry allows a peek at the expectations of certain corporations based on how they position their assets and manage their liabilities. That's essentially what's been done here. Use this guide as a condensed summary of the plans and programs of each company listed above. Perhaps in the future, the verbal analysis can be paired with a discounted cash flow analysis and projections of the balance sheet based on different price scenarios.

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